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**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

| **x** | **Quarterly Report Pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934** |
|-------|--------------------------------------------------------------------------------------------------------|

 

**For the quarterly period ended March 31, 2010**

 

**OR**

 

| **o** | **Transition Report Pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934** |
|-------|---------------------------------------------------------------------------------------------------------|

 

**For the transition periodfrom          to          **

 

**Commission File Number: 0-24081**

 

**EVOLVING SYSTEMS, INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                    | ** ** | **84-1010843**                       |
|-----------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of incorporation or  organization) |       | (I.R.S. Employer Identification No.) |
| ** **                                                      | ** ** | ** **                           |
| **9777 Pyramid Court, Suite 100 Englewood,  Colorado**     | ** ** | **80112**                            |
| (Address of principal executive offices)                        |       | (Zip Code)                           |

 

**(303) 802-1000**

(Registrant’s telephone number, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes xNo o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).    Yes  o    No  o

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer, or asmaller reporting company.  Seedefinition of “large accelerated filer”, “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

 

| Large  accelerated filer o                                              |   | Accelerated  filer o    |
|------------------------------------------------------------------------------|--------|------------------------------|
|                                                                         |   |                         |
| Non-accelerated  filer o  (Do not check if a smaller reporting company) |   | Smaller  reporting company x |

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).   Yes o  No x

 

As of May 3,2010 there were 10,021,459 shares outstanding of Registrant’s Common Stock (parvalue $0.001 per share).

 

 

 

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**EVOLVING SYSTEMS, INC.**

**Quarterly Report on Form 10-Q**

**March 31, 2010**

**Table of Contents**

 
| **PART I — FINANCIAL INFORMATION** |
|----------------------------------------------|
| Item 1                                       | Financial Statements |
|                                         | Condensed  Consolidated Balance Sheets as of March  31, 2010 and December 31,  2009 (Unaudited) |
|                                         | Condensed  Consolidated Statements of Operations for the Three Months Ended  March 31, 2010 and 2009 (Unaudited) |
|                                         | Condensed Consolidated Statements of Changes In  Stockholders’ Equity and Comprehensive Income (Loss) for the Three Months  Ended March 31, 2010 (Unaudited) |
|                                         | Condensed  Consolidated Statements of Cash Flows for the Three Months Ended March 31,  2010 and 2009 (Unaudited) |
|                                         | Notes to Unaudited Condensed Consolidated Financial  Statements |
| Item 2                                       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations |
| Item 3                                       | Quantitative  and Qualitative Disclosures About Market Risk |
| Item 4                                       | Controls and  Procedures |
| ** **                                   | ** ** |
| **PART II  — OTHER INFORMATION**   |
| Item 1                                       | Legal Proceedings |
| Item 1A                                      | Risk Factors |
| Item 2                                       | Unregistered  Sales of Equity Securities and Use of Proceeds |
| Item 3                                       | Defaults  upon Senior Securities |
| Item 4                                       | Submission  of Matters to a Vote of Security Holders |
| Item 5                                       | Other Information |
| Item 6                                       | Exhibits |
|                                         |   |
| Signature                                    |   |

 

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**PART I— FINANCIAL INFORMATION**

 

**ITEM1.  FINANCIAL STATEMENTS**

 

**EVOLVING SYSTEMS, INC.**

**CONDENSED CONSOLIDATED BALANCESHEETS**

**(in thousands except share data)**

**(unaudited)**

 
| ** **                                                                                                                                                                                | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| **ASSETS**                                                                                                                                                                                | ** ** | ** **         |       |                  |       |
| Current assets:                                                                                                                                                                           |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                 |       | $                  | 8,715      |                  | $          | 5,369 |   |
| Contract receivables, net of allowance for doubtful  accounts of $520 and $534 at March 31, 2010 and December 31, 2009,  respectively                                           |       | 6,810              |       | 11,344                |       |
| Unbilled work-in-progress                                                                                                                                                                 |       | 2,910              |       | 1,720                 |       |
| Deferred income taxes                                                                                                                                                                     |       | 8                  |       | 8                     |       |
| Prepaid and other current assets                                                                                                                                                          |       | 1,469              |       | 1,909                 |       |
| Total current assets                                                                                                                                                                      |       | 19,912             |       | 20,350                |       |
| Property and equipment, net                                                                                                                                                               |       | 1,208              |       | 1,196                 |       |
| Amortizable intangible assets, net                                                                                                                                                        |       | 1,597              |       | 1,864                 |       |
| Goodwill                                                                                                                                                                                  |       | 21,423             |       | 22,295                |       |
| Long-term restricted cash                                                                                                                                                                 |       | 50                 |       | 50                    |       |
| Other long-term assets                                                                                                                                                                    |       | 61                 |       | 82                    |       |
| Total assets                                                                                                                                                                              |       | $                  | 44,251     |                  | $          | 45,837 |   |
|                                                                                                                                                                                      |       |               |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                            |       |               |       |                  |       |
| Current liabilities:                                                                                                                                                                      |       |               |       |                  |       |
| Current portion of capital lease obligations                                                                                                                                              |       | $                  | 24         |                  | $          | 24 |   |
| Current portion of long-term debt                                                                                                                                                         |       | 350                |       | 333                   |       |
| Accounts payable and accrued liabilities                                                                                                                                                  |       | 4,349              |       | 4,502                 |       |
| Deferred income taxes                                                                                                                                                                     |       | 32                 |       | 29                    |       |
| Unearned revenue                                                                                                                                                                          |       | 10,170             |       | 10,688                |       |
| Total current liabilities                                                                                                                                                                 |       | 14,925             |       | 15,576                |       |
| Long-term liabilities:                                                                                                                                                                    |       |               |       |                  |       |
| Capital lease obligations, net of current portion                                                                                                                                         |       | 28                 |       | 35                    |       |
| Long-term debt, net of current portion                                                                                                                                                    |       | —             |       | 1,500                 |       |
| Deferred income taxes                                                                                                                                                                     |       | 187                |       | 257                   |       |
| Total liabilities                                                                                                                                                                         |       | 15,140             |       | 17,368                |       |
|                                                                                                                                                                                      |       |               |       |                  |       |
| Commitments and contingencies (Note 10)                                                                                                                                                   |       |               |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                |       |               |       |                  |       |
| Preferred stock, $0.001 par value; 2,000,000 shares  authorized; no shares issued and outstanding as of March 31, 2010 and  December 31, 2009                                   |       | —             |       | —                |       |
| Common stock, $0.001 par value; 40,000,000 shares  authorized; 10,019,122 and 9,930,682 shares issued and outstanding as of March 31,  2010 and December 31, 2009, respectively |       | 10                 |       | 10                    |       |
| Additional paid-in capital                                                                                                                                                                |       | 83,948             |       | 83,499                |       |
| Accumulated other comprehensive loss                                                                                                                                                      |       | (4,221             | )          | (3,242                | )          |
| Accumulated deficit                                                                                                                                                                       |       | (50,626            | )          | (51,798               | )          |
| Total stockholders’ equity                                                                                                                                                           |       | 29,111             |       | 28,469                |       |
| Total liabilities and stockholders’ equity                                                                                                                                           |       | $                  | 44,251     |                  | $          | 45,837 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

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**EVOLVINGSYSTEMS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

**(inthousands except per share data)**

**(unaudited)**

 
| ** **                                                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                   | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| **REVENUE**                                                                  | ** ** | ** **                            | ** ** | ** ** | ** ** |
| License  fees and services                                                   |       | $                                     | 5,625      |   | $ | 4,745 |   |
| Customer  support                                                            |       | 4,085                                 |       | 4,098 |   |
| Total  revenue                                                               |       | 9,710                                 |       | 8,843 |   |
|                                                                         |       |                                  |       |   |   |
| **COSTS OF REVENUE AND OPERATING EXPENSES**                                  |       |                                  |       |   |   |
| Costs  of license fees and services, excluding depreciation and amortization |       | 2,146                                 |       | 1,677 |   |
| Costs  of customer support, excluding depreciation and amortization          |       | 1,136                                 |       | 1,433 |   |
| Sales  and marketing                                                         |       | 1,910                                 |       | 1,887 |   |
| General  and administrative                                                  |       | 1,493                                 |       | 1,433 |   |
| Product  development                                                         |       | 1,208                                 |       | 695 |   |
| Depreciation                                                                 |       | 149                                   |       | 156 |   |
| Amortization                                                                 |       | 174                                   |       | 171 |   |
| Total  costs of revenue and operating expenses                               |       | 8,216                                 |       | 7,452 |   |
|                                                                         |       |                                  |       |   |   |
| Income  from operations                                                      |       | 1,494                                 |       | 1,391 |   |
|                                                                         |       |                                  |       |   |   |
| Other  income (expense)                                                      |       |                                  |       |   |   |
| Interest  income                                                             |       | 3                                     |       | 5 |   |
| Interest  expense                                                            |       | (39                                   | )          | (257 | ) |
| Foreign  currency exchange loss                                              |       | (42                                   | )          | (165 | ) |
| Other  expense, net                                                          |       | (78                                   | )          | (417 | ) |
|                                                                         |       |                                  |       |   |   |
| Income  before income taxes                                                  |       | 1,416                                 |       | 974 |   |
| Income  tax expense                                                          |       | 244                                   |       | 5 |   |
| Net  income                                                                  |       | $                                     | 1,172      |   | $ | 969 |   |
|                                                                         |       |                                  |       |   |   |
| Basic  income per common share                                               |       | $                                     | 0.12       |   | $ | 0.10 |   |
|                                                                         |       |                                  |       |   |   |
| Diluted  income per common share                                             |       | $                                     | 0.11       |   | $ | 0.10 |   |
|                                                                         |       |                                  |       |   |   |
| Weighted  average basic shares outstanding                                   |       | 9,995                                 |       | 9,765 |   |
| Weighted  average diluted shares outstanding                                 |       | 10,592                                |       | 9,847 |   |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

 

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**EVOLVING SYSTEMS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY**

**AND COMPREHENSIVE INCOME (LOSS)**

**(in thousands, except share data)**

**(unaudited)**

 
| ** **                                                        | ** ** | ** **       | ** ** | ** **  | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** **             | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------|------------|------------------|------------|-------------|------------|-------------------|------------|-----------------|------------|------------------------|------------|------------|------------|
| ** **                                                        | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional**    | ** ** | **Other**       | ** ** | ** **             | ** ** | **Total**  | ** ** |
| ** **                                                        | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Comprehensive** | ** ** | **Accumulated** | ** ** | **Stockholders’** | ** ** |
| ** **                                                        | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **Capital**       | ** ** | **Loss**        | ** ** | **Deficit**            | ** ** | **Equity** | ** ** |
| **Balance at December 31, 2009**                             | ** ** | **9,930,682**    | ** ** | **$**       | **10**     | ** **        | **$**      | **83,499**      | ** ** | **$**                  | **(3,242** | **)**      | **$**      | **(51,798** | **)** | **$** | **28,469** | ** ** |
| Stock option exercises                                            |       | 36,894           |       | —      |       | 187               |       | —          |       | —                 |       | 187        |       |
| Common Stock issued pursuant to the Employee Stock  Purchase Plan |       | 2,796            |       | —      |       | 15                |       | —          |       | —                 |       | 15         |       |
| Stock-based compensation expense                                  |       | —           |       | —      |       | 247               |       | —          |       | —                 |       | 247        |       |
| Restricted stock issuance                                         |       | 48,750           |       | —      |       | —            |       | —          |       | —                 |       | —     |       |
| Comprehensive income (loss):                                      |       |             |       |        |       |              |       |            |       |                   |       |       |       |
| Net income                                                        |       | —           |       | —      |       | —            |       | —          |       | 1,172                  |       |       |       |
| Foreign currency translation adjustment                           |       | —           |       | —      |       | —            |       | (979            | )          | —                 |       |       |       |
| Comprehensive income                                              |       |             |       |        |       |              |       |            |       |                   |       | 193        |       |
| **Balance at March 31, 2010**                                | ** ** | **10,019,122**   | ** ** | **$**       | **10**     | ** **        | **$**      | **83,948**      | ** ** | **$**                  | **(4,221** | **)**      | **$**      | **(50,626** | **)** | **$** | **29,111** | ** ** |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

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**EVOLVING SYSTEMS, INC.**

**CONDENSED****CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

 
| ** **                                                                         | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                         | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                         |       |                                  |       |   |   |
| Net income                                                                         |       | $                                     | 1,172      |   | $ | 969 |   |
| Adjustments to reconcile net income to net cash provided  by operating activities: |       |                                  |       |   |   |
| Depreciation                                                                       |       | 149                                   |       | 156 |   |
| Amortization of intangible assets                                                  |       | 174                                   |       | 171 |   |
| Amortization of debt issuance costs                                                |       | 26                                    |       | 33 |   |
| Stock based compensation                                                           |       | 247                                   |       | 201 |   |
| Unrealized foreign currency transaction losses, net                                |       | 42                                    |       | 165 |   |
| Benefit from foreign deferred income taxes                                         |       | (55                                   | )          | (29 | ) |
| Change in operating assets and liabilities:                                        |       |                                  |       |   |   |
| Contract receivables                                                               |       | 4,249                                 |       | 5,126 |   |
| Unbilled work-in-progress                                                          |       | (1,310                                | )          | (309 | ) |
| Prepaid and other assets                                                           |       | 396                                   |       | 31 |   |
| Accounts payable and accrued liabilities                                           |       | (46                                   | )          | (811 | ) |
| Unearned revenue                                                                   |       | (313                                  | )          | (919 | ) |
| Other long-term obligations                                                        |       | —                                |       | (1,190 | ) |
| Net cash provided by operating activities                                          |       | 4,731                                 |       | 3,594 |   |
|                                                                               |       |                                  |       |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES:**                                         |       |                                  |       |   |   |
| Purchase of property and equipment                                                 |       | (172                                  | )          | (208 | ) |
| Net cash used in investing activities                                              |       | (172                                  | )          | (208 | ) |
|                                                                               |       |                                  |       |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                         |       |                                  |       |   |   |
| Capital lease payments                                                             |       | (6                                    | )          | (5 | ) |
| Principal payments on long-term debt                                               |       | (1,487                                | )          | (1,131 | ) |
| Proceeds from the issuance of stock                                                |       | 202                                   |       | 15 |   |
| Net cash used in financing activities                                              |       | (1,291                                | )          | (1,121 | ) |
|                                                                               |       |                                  |       |   |   |
| Effect of exchange rate changes on cash                                            |       | 78                                    |       | (55 | ) |
|                                                                               |       |                                  |       |   |   |
| Net decrease in cash and cash equivalents                                          |       | 3,346                                 |       | 2,210 |   |
| Cash and cash equivalents at beginning of period                                   |       | 5,369                                 |       | 5,783 |   |
| Cash and cash equivalents at end of period                                         |       | $                                     | 8,715      |   | $ | 7,993 |   |
|                                                                               |       |                                  |       |   |   |
| Supplemental disclosure of other cash and non-cash  financing transactions:        |       |                                  |       |   |   |
| Interest paid                                                                      |       | $                                     | 16         |   | $ | 1,417 |   |
| Income taxes paid                                                                  |       | 25                                    |       | 258 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

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**EVOLVING SYSTEMS, INC.**

**NOTES TO UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 —BASIS OF PRESENTATION**

 

**Organization -**We are a provider of software solutionsand services to the wireless, wireline and cable markets. We maintainlong-standing relationships with many of the largest wireless, wireline andcable companies worldwide. Our customers rely on us to develop, deploy,enhance, maintain and integrate complex, highly reliable software solutions fora range of Operations Support Systems (“OSS”). We offer software products and solutions in four core areas:  service activation solutions used toactivate complex bundles of voice, video and data services for traditional andnext generation wireless and wireline networks; numbering solutions that enable carriers to comply withgovernment-mandated requirements regarding number portability as well asproviding phone number management and assignment capabilities; SIM cardactivation solutions used to dynamically allocate and assign resources to awireless device when it is first used, and mediation solutionssupporting data collection for both service assurance and billing applications.

 

**InterimConsolidated Financial Statements** — The accompanying unaudited condensed consolidatedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”) and inconformity with the instructions to Form 10-Q and Article 10 ofRegulation S-X and the related rules and regulations of the Securities andExchange Commission (“SEC”). Accordingly, certain information and note disclosures normally includedin financial statements prepared in accordance with GAAP have been condensed oromitted pursuant to such rules and regulations. However, we believe thatthe disclosures included in these financial statements are adequate to make theinformation presented not misleading. The unaudited condensed consolidatedfinancial statements included in this document have been prepared on the samebasis as the annual consolidated financial statements, and in our opinionreflect all adjustments, which include normal recurring adjustments necessaryfor a fair presentation in accordance with GAAP and SEC regulations for interimfinancial statements. The results for the three months ended March 31,2010 are not necessarily indicative of the results that we will have for anysubsequent period.  These unauditedcondensed consolidated financial statements should be read in conjunction withthe audited consolidated financial statements and the notes to those statementsfor the year ended December 31, 2009 included in our Annual Report on Form 10-K.

 

**Use ofEstimates -**Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the U.S. requires us to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities, at the date of the financial statements, aswell as the reported amounts of revenue and expenses during the reportingperiod. We made estimates with respect to revenue recognition for estimatedhours to complete projects accounted for using the percentage-of-completionmethod, allowance for doubtful accounts, income tax valuation allowance, fairvalues of long-lived assets, valuation of intangible assets and goodwill,useful lives for property, equipment and intangible assets, business combinations,capitalization of internal software development costs and fair value ofstock-based compensation amounts.  Actualresults could differ from these estimates.

 

**EarningsPer Share** - On July 1, 2009, we announced that our Board ofDirectors approved a one-for-two reverse split of our common stock. Commonstock and additional paid-in capital balances, all share amounts, stock optionamounts and per share/option prices appearing in this Quarterly Report on Form 10-Qreflect the reverse stock split for all periods presented.

 

**ForeignCurrency Translation -**Our functional currency is the U.S. dollar.  The functional currency of our foreignoperations is the respective local currency for each foreign subsidiary.  Assets and liabilities of foreign operationsdenominated in local currencies are translated at the spot rate in effect atthe applicable reporting date.  Ourconsolidated statements of operations are translated at the weighted averagerate of exchange during the applicable period. The resulting unrealized cumulative translation adjustment, net ofapplicable income taxes, is recorded as a component of accumulated othercomprehensive income (loss) in stockholders’ equity.  Realized and unrealized transaction gains andlosses generated by transactions denominated in a currency different from thefunctional currency of the applicable entity are recorded in other income(loss) in the period in which they occur.

 

**Principlesof Consolidation -**The consolidated financial statements include the accounts of EvolvingSystems, Inc. and subsidiaries, all of which are wholly owned.  All significant intercompany transactions andbalances have been eliminated in consolidation.

 

**Goodwill-**Goodwillis the excess of acquisition cost of an acquired entity over the fair value ofthe identifiable net assets acquired. Goodwill is not amortized, but tested for impairment annually orwhenever indicators of impairment exist. These indicators may include asignificant change in the business climate, legal factors, operating performanceindicators, competition, sale or disposition of a significant portion of thebusiness or other factors. For purposes of the goodwill evaluation, we comparethe fair value of each of our reporting units to its respective carryingamount. If the carrying value of a reporting unit were to exceed its fairvalue, we would then compare the fair value of the reporting unit’s goodwill toits carrying amount, and any excess of the carrying amount over the fair valuewould be charged to operations as an impairment loss.

 

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**IntangibleAssets -**Amortizableintangible assets consist primarily of purchased software and licenses,customer contracts and relationships, trademarks and tradenames, and businesspartnerships acquired in conjunction with our purchases of CMS Communications, Inc.(“CMS”), Telecom Software Enterprises, LLC (“TSE”) and Tertio Telecoms Ltd. (“EvolvingSystems U.K.”).  These definite lifeassets are amortized using the straight-line method over their estimated lives.

 

We assess theimpairment of identifiable intangibles if events or changes in circumstancesindicate that the carrying value of the asset may not be recoverable. Factorsthat we consider significant which could trigger an impairment analysis includethe following:

 

·                  Significant under-performance relative tohistorical or projected future operating results;

 

·                  Significant changes in the manner of useof the acquired assets or the strategy of the overall business;

 

·                  Significant negative industry or economictrends; and/or

 

·                  Significant decline in our stock pricefor a sustained period.

 

If, as a result ofthe existence of one or more of the above indicators of impairment, wedetermine that the carrying value of intangibles and/or long-lived assets maynot be recoverable, we compare the estimated undiscounted cash flows expectedto result from the use of the asset and its eventual disposition to the asset’scarrying amount. If an amortizable intangible or long-lived asset is not deemedto be recoverable, we recognize an impairment loss representing the excess ofthe asset’s carrying value over its estimated fair value.

 

**FairValue of Financial Instruments -**The carrying amounts for certain financialinstruments, including cash and cash equivalents, contract receivables andaccounts payable, approximate fair value due to their short maturities.  We estimate the fair value of our debt basedon current rates offered to us for debt of the same remaining maturities, ifavailable, or if not available, based on discounted future cash flows usingcurrent market interest rates.  As of March 31,2010, we estimated the fair value of the balance due on our U.K. revolvingline-of-credit was $0.4 million. As of December 31, 2009, we estimated thefair value of our fixed rate senior term loan and revolver were $0.3 millionand $1.5 million, respectively.

 

**RevenueRecognition -**Werecognize revenue when an agreement is signed, the fee is fixed or determinableand collectability is reasonably assured. We recognize revenue from two primarysources: license fees and services, and customer support.   Themajority of our license fees and services revenue is generated from fixed-pricecontracts, which provide for licenses to our software products and services tocustomize such software to meet our customers’ use.   When the services are determined to beessential to the functionality of the delivered software, we recognize revenueusing the percentage-of-completion method of accounting. We estimate thepercentage-of-completion for each contract based on the ratio of direct laborhours incurred to total estimated direct labor hours and recognize revenuebased on the percent complete multiplied by the contract amount.  Since estimated direct labor hours, andchanges thereto, can have a significant impact on revenue recognition, theseestimates are critical and we review them regularly.  We record amounts billed in advance ofservices being performed as unearned revenue. Unbilled work-in-progressrepresents revenue earned but not yet billable under the terms of thefixed-price contracts. All such amounts are expected to be billed and collectedwithin 12 months.

 

We may encounter budgetand schedule overruns on fixed-price contracts caused by increased laboror overhead costs. We make adjustments to cost estimates in the period in whichthe facts requiring such revisions become known. We record estimated losses, ifany, in the period in which current estimates of total contract revenue andcontract costs indicate a loss. If revisions to cost estimates are obtainedafter the balance sheet date but before the issuance of the interim or annual financialstatements, we make adjustments to the interim or annual financial statementsaccordingly.

 

In arrangementswhere the services are not essential to the functionality of the deliveredsoftware, we recognize license revenue when a license agreement has beensigned, delivery has occurred, the fee is fixed or determinable andcollectability is reasonably assured. Where applicable, we unbundle and recordas revenue fees from multiple element arrangements as the elements aredelivered to the extent that vendor specific objective evidence (“VSOE”) offair value of the undelivered elements exist. If VSOE for the undeliveredelements does not exist, we defer fees from such arrangements until the earlierof the date that VSOE does exist on the undelivered elements or all of theelements have been delivered.

 

We recognize revenue fromfixed-price service contracts using the proportional performance method ofaccounting, which is similar to the percentage-of-completion method describedabove. We recognize revenue from professional services provided pursuant totime-and-materials based contracts and training services as the services areperformed, as that is when our obligation to our customers under sucharrangements is fulfilled.

 

We recognize customersupport, including maintenance revenue, ratably over the service contractperiod. When maintenance is bundled with the original license fee arrangement,its fair value, based upon VSOE, is deferred and recognized during the periodswhen services are provided.

 

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**Stock-based Compensation -** We account for stock-based compensationby applying a fair-value-based measurement method to account for share-basedpayment transactions with employees and directors and record compensation costfor all stock awards granted after January 1, 2006 and awards modified,repurchased, or cancelled after that date. We record compensation costs associatedwith the vesting of unvested options on a straight-line basis over the vestingperiod.  Stock-based compensation is anon-cash expense because we settle these obligations by issuing shares of ourcommon stock instead of settling such obligations with cash payments.    We use the Black-Scholes model to estimatethe fair value of each option grant on the date of grant.  This model requires the use of estimates forexpected term of the options and expected volatility of the price of our commonstock.

 

**IncomeTaxes**- Werecord deferred tax assets and liabilities for the estimated future tax effectsof temporary differences between the tax bases of assets and liabilities andamounts reported in the accompanying consolidated balance sheets, as well asoperating loss and tax credit carry-forwards. We measure deferred tax assetsand liabilities using enacted tax rates expected to be applied to taxableincome in the years in which those temporary differences are expected to berecovered or settled.  We reduce deferredtax assets by a valuation allowance if, based on available evidence, it is morelikely than not that these benefits will not be realized.  We evaluate tax benefits recorded in ourconsolidated financial statements and record accruals for any amounts deemednot probable of being sustained.

 

We use arecognition threshold and a measurement attribute for the financial statementrecognition and measurement of tax positions taken or expected to be taken in atax return.  For those benefits to berecognized, a tax position must be more likely than not to be sustained uponexamination by taxing authorities.  Therewas no material impact on the company’s consolidated financial position andresults of operations as a result of this adoption.

 

As of March 31,2010 and December 31, 2009, we had no liability for unrecognized taxbenefits.  We do not believe there willbe any material changes to our unrecognized tax positions over the next twelvemonths.

 

**NOTE 2 —GOODWILL AND INTANGIBLE ASSETS**

 

We recordedgoodwill as a result of three acquisitions which occurred over the period from November 2003to November 2004. We acquired CMS in November 2003, TSE in October 2004and Evolving Systems U.K. in November 2004.

 

Changes in the carrying amount of goodwill by reporting unit were asfollows (in thousands):

 
| ** **                                             | ** ** | **License and Services** | ** ** | **Customer Support** | ** ** | **Total** | ** ** |
|--------------------------------------------------------|------------|--------------------------|------------|----------------------|------------|-----------|------------|
| ** **                                             | ** ** | **US**                   | ** ** | **UK**               | ** ** | **US**    | ** ** | **UK** | ** ** | **Goodwill** | ** ** |
| Balance  as of December 31, 2009                  |       | $                        | —     |                 | $          | 7,274     |       | $ | 6,033 |   | $ | 8,988 |   | $ | 22,295 |   |
| Effects  of changes in foreign currency exchange rates |       | —                   |       | (390                 | )          | —    |       | (482 | ) | (872 | ) |
| Balance  as of March 31, 2010                     |       | $                        | —     |                 | $          | 6,884     |       | $ | 6,033 |   | $ | 8,506 |   | $ | 21,423 |   |

 

We conducted our annual goodwill impairment test as of July 31,2009, and we determined that goodwill was not impaired as of the test date.From July 31, 2009 through March 31, 2010, no events have occurredthat we believe may have impaired goodwill.

 

We amortized identifiable intangible assets on a straight-line basis overestimated lives ranging from one to seven years and include the cumulativeeffects of foreign currency exchange rates. As of March 31, 2010 and December 31, 2009, identifiableintangibles were as follows (in thousands):

 
| ** **                 | ** ** | **March 31, 2010** | ** ** | **December 31, 2009**    | ** ** | **Weighted-**             | ** ** |
|----------------------------|------------|-------------------------|------------|-------------------------------|------------|---------------------------|------------|
| ** **                 | ** ** | **(1)  Gross  Amount**  | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** | **(1)  Gross  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** | **Average  Amortization  Period** | ** ** |
| Purchased  software        |       | $                       | 1,637      |                          | $          | 1,301                     |       | $ | 336 |   | $ | 1,712 |   | $ | 1,287 |   | $ | 425 |   | 4.6 yrs |   |
| Purchased  licenses        |       | 227                     |       | 227                           |       | —                    |       | 227 |   | 227 |   | — |   | 2.3 yrs |   |
| Trademarks  and tradenames |       | 676                     |       | 362                           |       | 314                       |       | 715 |   | 357 |   | 358 |   | 7.0 yrs |   |
| Business  partnerships     |       | 110                     |       | 83                            |       | 27                        |       | 116 |   | 82 |   | 34 |   | 5.0 yrs |   |
| Customer  relationships    |       | 3,065                   |       | 2,145                         |       | 920                       |       | 3,177 |   | 2,130 |   | 1,047 |   | 5.3 yrs |   |
|                       |       | $                       | 5,715      |                          | $          | 4,118                     |       | $ | 1,597 |   | $ | 5,947 |   | $ | 4,083 |   | $ | 1,864 |   | 5.2 yrs |   |

 

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(1) Changes in intangible gross values as of March 31, 2010 compared to December 31,2009 are the direct result of changes in foreign currency exchange rates forthe periods then ended.

 

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Amortizationexpense of identifiable intangible assets was $0.2 million for the three monthsended March 31, 2010 and 2009.  AsEvolving Systems U.K. uses the British Pound Sterling as its functionalcurrency, the amount of future amortization actually recorded will be basedupon exchange rates in effect at that time. Expected future amortizationexpense related to identifiable intangibles based on our carrying amount as of March 31,2010 was as follows (in thousands):

 
| **Twelve months ending March 31,** | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|------------|------------|
| 2011                                    |       | $          | 670        |   |
| 2012                                    |       | 452        |       |
| 2013                                    |       | 380        |       |
| 2014                                    |       | 95         |       |
|                                    |       | $          | 1,597      |   |

 

**NOTE 3 —EARNINGS PER COMMON SHARE**

 

Wecompute basic earnings per share (“EPS”) by dividing net income or lossavailable to common stockholders by the weighted average number of sharesoutstanding during the period, including common stock issuable underparticipating securities. We compute diluted EPS using the weighted averagenumber of shares outstanding, including participating securities, plus allpotentially dilutive common stock equivalents. Common stock equivalents consistof stock options.

 

We have a policyproviding that unvested share-based payment awards that contain non-forfeitablerights to dividends or dividend equivalents, whether paid or unpaid, areparticipating securities and shall be included in the computation of both basicand diluted earnings per share.   Upon adoption, both basic anddiluted income per share for 2009 and 2008 remained unchanged.

 

Thefollowing is the reconciliation of the denominator of the basic and diluted EPScomputations (in thousands):

 
| ** **                                                 | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                 | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Basic  income per common and preferred share:              |       |                                  |       |   |   |
| Net  income available to common and preferred stockholders |       | $                                     | 1,172      |   | $ | 969 |   |
| Basic  weighted average shares outstanding                 |       | 9,995                                 |       | 9,765 |   |
| Basic  income per common and preferred share               |       | $                                     | 0.12       |   | $ | 0.10 |   |
|                                                       |       |                                  |       |   |   |
| Diluted  income per common and preferred share:            |       |                                  |       |   |   |
| Net  income available to common and preferred stockholders |       | $                                     | 1,172      |   | $ | 969 |   |
| Weighted  average common shares outstanding                |       | 9,995                                 |       | 9,765 |   |
| Effect  of dilutive securities – options              |       | 597                                   |       | 82 |   |
| Diluted  weighted average shares outstanding               |       | 10,592                                |       | 9,847 |   |
| Diluted  income per common and preferred share             |       | $                                     | 0.11       |   | $ | 0.10 |   |

 

Forthe three months ended March 31, 2010 and 2009, 0.4 million and 1.9million shares of common stock were excluded from the dilutive stockcalculation because their exercise prices were greater than the average fairvalue of our common stock for the period.

 

**NOTE 4 —SHARE-BASED COMPENSATION**

 

We account forstock-based compensation by applying a fair-value-based measurement method toaccount for share-based payment transactions with employees and directors andrecord compensation cost for all stock awards granted after January 1,2006 and awards modified, repurchased, or cancelled after that date, using themodified prospective method. We record compensation costs associated with thevesting of unvested options on a straight-line basis over the vesting period.We recognized $0.2 million for each of the three months ended March 31,2010 and 2009 of compensation expense in the consolidated statements ofoperations, with respect to our stock-based compensation plans.  The following table summarizes stock-basedcompensation expenses recorded in the consolidated statement of operations (inthousands):

 
| ** **                                                                  | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                  | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Cost  of license fees and services, excluding depreciation and amortization |       | $                                     | 13         |   | $ | 17 |   |
| Cost  of customer support, excluding depreciation and amortization          |       | 2                                     |       | 2 |   |
| Sales  and marketing                                                        |       | 31                                    |       | 37 |   |
| General  and administrative                                                 |       | 173                                   |       | 123 |   |
| Product  development                                                        |       | 28                                    |       | 22 |   |
|                                                                        |       | $                                     | 247        |   | $ | 201 |   |

 

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**StockIncentive Plans**

 

In January 1996,our stockholders approved an Amended and Restated Stock Option Plan (the “OptionPlan”).  Under the Option Plan, asamended, and after the reverse stock split, 4,175,000 shares were reserved forissuance.  Options issued under theOption Plan were at the discretion of the Board of Directors, including thevesting provisions of each stock option granted. Options were granted with an exerciseprice equal to the closing price of our common stock on the date of grant,generally vest over four years and expire no more than ten years from the dateof grant. The Option Plan terminated on January 18, 2006; options grantedbefore that date were not affected by the plan termination.  At March 31, 2010 and December 31,2009, 1.6 million and 1.7 million options remained outstanding under the OptionPlan, respectively.

 

In March 2007,upon the hiring of our Vice President of World Wide Sales and Marketing, inaccordance with NASDAQ Marketplace Rule 4350(i)(1)(a)(iv), the Board ofDirectors approved an inducement award under a stand-alone equity incentiveplan.  We granted 50,000 non-qualifiedoptions to purchase shares of our common stock at an exercise price equal tothe closing price of our common stock on the date of grant.  The options vest over four years and expireten years from the date of grant. At March 31, 2010 and December 31,2009, 50,000 options remained outstanding under this plan.

 

In June 2007,our stockholders approved the 2007 Stock Incentive Plan (the “2007 Stock Plan”).  As a result of the reverse stock split, amaximum of 1,000,000 shares can be issued under the 2007 Stock Plan. Awardspermitted under the 2007 Stock Plan include: Stock Options, Stock Appreciation Rights, Restricted Stock, RestrictedStock Units, Performance Awards and Other Stock-Based Awards.  Awards issued under the 2007 Stock Plan areat the discretion of the Board of Directors. As applicable, awards are granted with an exercise price equal to theclosing price of our common stock on the date of grant, generally vest overfour years and expire no more than ten years from the date of grant.  At March 31, 2010 and December 31,2009, 0.7 million and 0.6 million options remained outstanding under the 2007Stock Plan, respectively.

 

In January 2010,under the 2007 Stock Plan, we awarded a total of 48,750 shares of restrictedstock to members of our Board of Directors and senior management. There were noissuances of restricted stock during the three months ended March 31,2009. During the three months ended March 31, 2010 and 2009, 11,000 and10,000 shares of restricted stock vested, respectively.  There were no forfeitures of restricted stockduring the three months ended March 31, 2010 and 2009. The fair marketvalue for share-based compensation expensing is equal to the closing price ofour common stock on the date of grant. The restrictions on the stock award arereleased generally over four years for senior management and over one year forboard members.

 

The fair value ofeach option grant is estimated on the date of grant using the Black-Scholesmodel.  The Black-Scholes model uses fourassumptions to calculate the fair value of each option grant.  The expected term of share options granted isderived using the simplified method, which we adopted in January 2008. Therisk-free interest rate is based upon the rate currently available onzero-coupon U.S. Treasury instruments with a remaining term equal to theexpected term of the stock options.  Theexpected volatility is based upon historical volatility of our common stockover a period equal to the expected term of the stock options.  The expected dividend yield is zero and isbased upon historical and anticipated payment of dividends.  The weighted-average assumptions used in thefair value calculations are as follows:

 
| ** **               | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------|------------|---------------------------------------|------------|
| ** **               | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Expected  term (years)   |       | 6.0                                   |       | 5.3 |   |
| Risk-free  interest rate |       | 2.6                                   | %          | 1.9 | % |
| Expected  volatility     |       | 73.7                                  | %          | 79.2 | % |
| Expected  dividend yield |       | 0                                     | %          | 0 | % |

 

The following is asummary of stock option activity under the plans for the three months ended March 31,2010:

 
| ** **                                     | ** ** | ** **         | ** ** | ** **    | ** ** | **Weighted-**   | ** ** | ** **         | ** ** |
|------------------------------------------------|------------|--------------------|------------|---------------|------------|-----------------|------------|--------------------|------------|
| ** **                                     | ** ** | ** **         | ** ** | ** **    | ** ** | **Average**     | ** ** | ** **         | ** ** |
| ** **                                     | ** ** | ** **         | ** ** | **Weighted-** | ** ** | **Remaining**   | ** ** | **Aggregate**      | ** ** |
| ** **                                     | ** ** | **Number of**      | ** ** | **Average**   | ** ** | **Contractual** | ** ** | **Intrinsic**      | ** ** |
| ** **                                     | ** ** | **Shares**         | ** ** | **Exercise**  | ** ** | **Term**        | ** ** | **Value**          | ** ** |
| ** **                                     | ** ** | **(in thousands)** | ** ** | **Price**     | ** ** | **(Years)**     | ** ** | **(in thousands)** | ** ** |
| Options  outstanding at December 31, 2009 |       | 2,264              |       | $             | 5.57       |            |       |               | $          | 4,304 |   |
| Options  granted                               |       | 185                |       | $             | 6.16       |            |       |               |       |   |
| Less  options forfeited                        |       | (1                 | )          | $             | 3.80       |            |       |               |       |   |
| Less  options exercised                        |       | (37                | )          | $             | 5.07       |            |       |               |       |   |
| Options  outstanding at March 31, 2010    |       | 2,411              |       | $             | 5.62       |            | 5.32       |               | $          | 5,573 |   |
|                                           |       |               |       |          |       |            |       |               |       |
| Options  exercisable at March 31, 2010    |       | 1,969              |       | $             | 5.89       |            | 4.51       |               | $          | 4,484 |   |

 

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All stock option amounts have been adjusted for thereverse stock split.

 

Theweighted-average grant-date fair value of stock options granted during thethree months ended March 31, 2010 and 2009 was $3.92 and $1.21,respectively.

 

As of March 31,2010, there was approximately $1.7 million of total unrecognized compensationcosts related to unvested stock options. These costs are expected to be recognized over a weighted average periodof 2.6 years.

 

The total fairvalue of stock options vested during the three months ended March 31, 2010and 2009 was $0.1 million and $0.2 million, respectively.

 

The deferredincome tax benefits from stock option expense related to Evolving Systems U.K.totaled approximately $14,000 and $15,000 for the three months ended March 31,2010 and 2009, respectively.

 

Cash received fromstock option exercises for the three months ended March 31, 2010 was $0.2million. There were no options exercised during the three months ended March 31,2009.

 

**EmployeeStock Purchase Plan**

 

Under the EmployeeStock Purchase Plan (“ESPP”), we were previously authorized to issue up to1,100,000 shares of our common stock to full-time employees, nearly all of whomare eligible to participate. After the reverse stock split, we are nowauthorized to issue up to 550,000 shares under the ESPP. Under the terms of theESPP, employees may elect to have up to 15% of their gross compensationwithheld through payroll deduction to purchase our common stock, capped at$25,000 annually and no more than 10,000 shares per offering period. Thepurchase price of the stock is 85% of the lower of the market price at thebeginning or end of each three-month participation period. As of March 31,2010, there were approximately 85,000 shares available for purchase.  For the three months ended March 31,2010 and 2009, we recorded compensation expense of $4,000 and $5,000,respectively, associated with grants under the ESPP which includes the fairvalue of the look-back feature of each grant as well as the 15% discount on thepurchase price.  This expense fluctuateseach period primarily based on the level of employee participation.

 

The fair value ofeach purchase made under our ESPP is estimated on the date of purchase usingthe Black-Scholes model.  TheBlack-Scholes model uses four assumptions to calculate the fair value of eachpurchase.  The expected term of eachpurchase is based upon the three-month participation period of eachoffering.  The risk-free interest rate isbased upon the rate currently available on zero-coupon U.S. Treasuryinstruments with a remaining term equal to the expected term of eachoffering.  The expected volatility isbased upon historical volatility of our common stock.  The expected dividend yield is based uponhistorical and anticipated payment of dividends.  The weighted average assumptions used in thefair value calculations are as follows:

 
| ** **               | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------|------------|---------------------------------------|------------|
| ** **               | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Expected  term (years)   |       | 0.25                                  |       | 0.25 |   |
| Risk-free  interest rate |       | 0.2                                   | %          | 0.2 | % |
| Expected  volatility     |       | 60.2                                  | %          | 65.3 | % |
| Expected  dividend yield |       | 0                                     | %          | 0 | % |

 

Cash received fromemployee stock plan purchases for each of the three month periods ended March 31,2010 and 2009 was $15,000.

 

We issued sharesrelated to the ESPP of approximately 3,000 and 11,000 for the three monthsended March 31, 2010 and 2009, respectively.

 

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**NOTE 5 — CONCENTRATION OF CREDIT RISK**

 

For the three months ended March 31, 2010, two significantcustomers (defined as contributing at least 10%) accounted for 31% (18% and13%) of total revenue.  These customersare a large telecommunications operator in the U.S. and a large telecommunications operatorin Indonesia.  For the three months ended March 31,2009, one significant customer accounted for 26% of total revenue.  This customer is large telecommunicationsoperator located in the U.S.

 

As of March 31, 2010, two significant customers accounted forapproximately 32% (16% and 16%) of contract receivables and unbilledwork-in-progress.  These customers are a largetelecommunications operator in the U.S. and a large telecommunications operator in Indonesia.  AtDecember 31, 2009, one significant customer accounted for approximately38% of contract receivables and unbilled work-in-progress.  This customer is a largetelecommunications operator located in the U.S.

 

**NOTE 6 — LONG-TERM DEBT**

 

Long-term debt consistsof the following (in thousands):

 
| ** **                                                                                                                                                                                                                                                                                                                               | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                               | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| Senior  term loan with financial institution, interest at a fixed rate of 8.25%, principal  installments and interest payments are due monthly with final maturity on  February 22, 2010. The loan is secured by substantially all of our  assets.                                                                                  |       | $                  | —     |                  | $          | 333 |   |
| $3.5  million U.K. revolving credit facility payable to financial institution,  interest at Prime Rate plus 0.5%; interest rate was 3.75% at March 31,  2010 and December 31, 2009. Interest is payable monthly with remaining  principal due February 22, 2011. The loan is secured by substantially  all of our assets. |       | 350                |       | 1,500                 |       |
| Total  debt                                                                                                                                                                                                                                                                                                                              |       | 350                |       | 1,833                 |       |
| Less  current portion                                                                                                                                                                                                                                                                                                                    |       | (350               | )          | (333                  | )          |
| Long-term  debt, excluding current portion                                                                                                                                                                                                                                                                                               |       | $                  | —     |                  | $          | 1,500 |   |

 

Our $2.5 million U.S. revolving credit facility (“U.S. Revolving Facility”)bears interest at Prime Rate plus 0.5%. Prime Rate was 3.25% as of March 31, 2010.  Borrowings under the revolving facilities arelimited to a percentage of our eligible accounts receivable and cash.  The U.S. Revolving Facility is secured by allassets of Evolving Systems, Inc. and is subject to certain affirmative andnegative covenants, including financial covenants related to maintaining aspecified ratio of debt to EBITDA, as defined, minimum EBITDA, minimumliquidity, and a specified fixed charge ratio. All accrued interest on outstanding borrowings under the U.S. RevolvingFacility is paid monthly, with any outstanding balance due with a finalmaturity of February 22, 2011.  Asof March 31, 2010, we had $2.5 million in availability, but no borrowingoutstanding under this U.S. Revolving Facility.

 

Our $3.5 million U.K. Revolving Facility bears interest at Prime Rateplus 0.5%.  Prime Rate was 3.25% as of March 31,2010.  Borrowings under the U.K.Revolving Facility are limited to a percentage of our eligible accountsreceivable and cash.  The U.K. RevolvingFacility is secured by all assets of Evolving Systems Holdings Ltd. andEvolving Systems Ltd. and is subject to certain affirmative and negativecovenants, including financial covenants related to maintaining a specifiedratio of debt to EBITDA, as defined, minimum EBITDA, minimum liquidity, and aspecified fixed charge ratio. All accrued interest on outstanding borrowingsunder the U.K. Revolving Facility is paid monthly, with any outstanding balancedue with a final maturity of February 22, 2011.  As of March 31, 2010, we had $3.1million in availability and $0.4 million in borrowings outstanding under thisU.K. Revolving Facility.

 

We were in compliancewith all of our debt covenants as of March 31, 2010 and December 31,2009.

 

**NOTE 7 —INCOME TAXES**

 

Werecorded net income tax expense of $244,000 and $5,000 for the three monthsended March 31, 2010 and 2009, respectively.  The net expense during the three months endedMarch 31, 2010 consisted of income tax expense of $299,000 and a deferredtax benefit of $55,000. The current tax expense primarily related to income taxrelated to our U.K.-based operations, estimated Alternative Minimum Tax (“AMT”)due in the U.S. and Minimum Alternative Tax (“MAT”) related to our Indiansubsidiary. The deferred tax benefit was related to intangible assets from ourU.K.-based operations.

 

Thenet expense during the three months ended March 31, 2009 consisted ofincome tax expense of $56,000 and a deferred tax benefit of $51,000, related toour U.K.-based operations. The income tax expense and the deferred tax benefitwere primarily related to our U.K.-based operations.

 

Inconjunction with the acquisition of Evolving Systems U.K., we recorded certainidentifiable intangible assets.  Sincethe amortization of these identifiable intangibles is not deductible for incometax purposes, we established a long-term deferred tax liability of $4.6 millionat the acquisition date for the expected difference between what would beexpensed for financial reporting 

 

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purposes and what would be deductible for income tax purposes. As of March 31,2010 and December 31, 2009, this component of the deferred tax liabilitywas $0.4 million and $0.5 million, respectively.  This deferred tax liability relates toEvolving Systems U.K., and has no impact on our ability to recover U.S.-baseddeferred tax assets.  This deferred taxliability will be recognized as a reduction of deferred income tax expense asthe identifiable intangibles are amortized.

 

As of March 31, 2010and December 31, 2009 we continued to maintain a full valuation allowanceon the domestic net deferred tax asset as we have determined it is more likelythan not that we will not realize our domestic deferred tax assets.  Such assets primarily consist of certain netoperating loss carryforwards.  Weassessed the realizability of our domestic deferred tax assets using allavailable evidence.  In particular, we consideredboth historical results and projections of profitability for the reasonablyforeseeable future periods.  We arerequired to reassess our conclusions regarding the realization of our deferredtax assets at each financial reporting date. A future evaluation could resultin a conclusion that all or a portion of the valuation allowance is no longernecessary, which could have a material impact on our results of operations andfinancial position.

 

As of March 31,2010 and December 31, 2009, we had no liability for unrecognized taxbenefits.  We do not believe there willbe any material changes in our unrecognized tax positions over the next twelvemonths.

 

We conductbusiness globally and, as a result, Evolving Systems, Inc. or one or moreof our subsidiaries file income tax returns in the U.S. federal jurisdictionand various state and foreign jurisdictions. In the normal course of business, we are subject to examination bytaxing authorities throughout the world, namely the United Kingdom, Germany andIndia.

 

**NOTE 8 —STOCKHOLDERS’ EQUITY**

 

**Certain****Anti-TakeoverProvisions/Agreements with Stockholders**

 

Our restatedcertificate of incorporation allows the board of directors to issue up to2,000,000 shares of preferred stock and to determine the price, rights,preferences and privileges of those shares without any further vote or actionby our stockholders. The rights of the holders of our common stock will besubject to, and may be adversely affected by, the rights of the holders of anypreferred stock that may be issued in the future. Issuance of preferred stock,while providing desired flexibility in connection with possible acquisitionsand other corporate purposes, could make it more difficult for a third party toacquire a majority of our outstanding voting stock. As of March 31, 2010and December 31, 2009 no shares of Series B Preferred Stock areoutstanding.

 

In addition, weare subject to the anti-takeover provisions of Section 203 of DelawareGeneral Corporation Law which prohibit us from engaging in a “businesscombination” with an “interested stockholder” for a period of three yearsafter the date of the transaction in which the person became an interestedstockholder, unless the business combination is approved in the prescribedmanner. The application of Section 203 and certain provisions of ourrestated certificate of incorporation, including a classified board ofdirectors, may have the effect of delaying or preventing changes in control ofour management, which could adversely affect the market price of our commonstock by discouraging or preventing takeover attempts that might result in thepayment of a premium price to our stockholders.

 

On March 4, 2009 ourBoard of Directors adopted a Stockholder Rights Plan (the “Rights Agreement)that is designed to strengthen the ability of the Board of Directors to protectEvolving Systems’ stockholders.  The Rights Agreement was not adopted inresponse to any unsolicited offer or takeover attempt. Under the plan, eachcommon stockholder at the close of business on March 16, 2009 received adividend of one right for each share of our common stock held of record on thatdate.  Each right will entitle the holder to purchase, in certaincircumstances, two one-hundredths of a share of newly-created Series C juniorparticipating preferred stock for an initial purchase price of $8.00 per share.The rights distribution was not taxable to stockholders and the distribution ofrights under the plan will not interfere with the Company’s business plans orbe dilutive to or affect our reported per share results. The rights willgenerally become exercisable ten business days after any person has become thebeneficial owner of 22.5% or more of our common stock or has commenced a tenderor exchange offer which, if consummated, would result in any person becomingthe beneficial owner of 22.5% or more of our common stock.

 

On December 10,2009, the Board of Directors approved an amendment to the RightsAgreement.  The amendment increases, from 22.5% to 25.0%, the percentage ofour common stock that a person or group of affiliated or associated persons maybeneficially own without triggering the exercisability of the RightsAgreement.  All other provisions of the Rights Agreement remain unchanged.

 

On December 11,2009, we received a letter from the Singer Trust informing us that as theresult of the appointment of John B. Spirtos to our Board of Directors and ourapproval of the amendment to the Rights Agreement the Singer Trust will vote infavor of the reelection of Philip Neches and Richard Ramlall to our Board ofDirectors at our 2010 annual meeting of stockholders and the Singer Trust willnot seek or otherwise support additional stockholder protections or reforms atthe meeting.

 

On April 20,2010, our Board of Directors approved an amendment to the Rights Agreementincreasing, from 25.0% to 29.0%, the percentage of the our common stock, that aperson or group of affiliated or associated persons may beneficially ownwithout triggering the exercisability of the Rights Agreement. All otherprovisions of the Rights Agreement remain unchanged.

 

On April 20,2010, we entered into an agreement with the Singer Trust (the “Trust”), toincrease the size of the Compensation Committee of the Board of Directors fromthree (3) members to four (4) and, for so long as the Trust is thebeneficial holder of twenty

 

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percent (20%) or more of our common stock , there would be at least two(2) persons to the Compensation Committee who have been nominated to theBoard of Directors by the Trust. We also agreed that all action by theCompensation Committee would require unanimous approval of the members. TheTrust agreed that it would vote its shares at the 2010 annual meeting ofstockholders in favor of a proposal to amend the Company’s 2007 Stock IncentivePlan to provide that, exclusive of shares of Common Stock subject to awardsexisting as at April 20, 2010 (which shares, when no longer subject tosuch awards, may not be added to the Plan’s share reserve), the total number ofshares of Common Stock authorized for issuance under the plan would be 250,000shares and to provide for certain other amendments.

 

**NOTE 9 —SEGMENT INFORMATION**

 

Wedefine operating segments as components of our enterprise for which separatefinancial information is reviewed regularly by the chief operatingdecision-makers to evaluate performance and to make operating decisions. We haveidentified our Chief Executive Officer and Chief Financial Officer as our chiefoperating decision-makers (“CODM”). These chief operating decision makersreview revenues by segment and review overall results of operations.

 

Wecurrently operate our business as two operating segments based on revenuetype:  license fees and services revenueand customer support revenue (as shown on the consolidated statements ofoperations).  License fees and services (“L&S”)revenue represents the fees received from the license of software products andthose services directly related to the delivery of the licensed products, suchas fees for custom development and integration services.  Customer support (“CS”) revenue includesannual support fees, recurring maintenance fees, fees for maintenance upgradesand warranty services.  Warranty servicesthat are similar to software maintenance services are typically bundled with alicense sale. Total assets by segment have not been disclosed as theinformation is not available to the chief operating decision-makers.

 

Segmentinformation is as follows (in thousands):

 
| ** **                                                                  | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                  | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| **Revenue**                                                                 | ** ** | ** **                            | ** ** | ** ** | ** ** |
| License  fees and services                                                  |       | $                                     | 5,625      |   | $ | 4,745 |   |
| Customer  support                                                           |       | 4,085                                 |       | 4,098 |   |
| Total  revenue                                                              |       | 9,710                                 |       | 8,843 |   |
|                                                                        |       |                                  |       |   |   |
| **Revenue less costs of revenue, excluding depreciation and  amortization** |       |                                  |       |   |   |
| License  fees and services                                                  |       | 3,479                                 |       | 3,068 |   |
| Customer  support                                                           |       | 2,949                                 |       | 2,665 |   |
|                                                                        |       | 6,428                                 |       | 5,733 |   |
| **Unallocated Costs**                                                       |       |                                  |       |   |   |
| Other  operating expenses                                                   |       | 4,611                                 |       | 4,015 |   |
| Depreciation  and amortization                                              |       | 323                                   |       | 327 |   |
| Interest  income                                                            |       | (3                                    | )          | (5 | ) |
| Interest  expense                                                           |       | 39                                    |       | 257 |   |
| Foreign  currency exchange (gain) loss                                      |       | 42                                    |       | 165 |   |
| **Income before income taxes**                                              |       | $                                     | 1,416      |   | $ | 974 |   |

 

***Geographic Regions***

 

We are headquartered in Englewood, a suburb of Denver,Colorado.  We use customer locations asthe basis for attributing revenues to individual countries.  We provide products and services on a globalbasis through our headquarters and our London-based Evolving Systems U.K.subsidiary.  Additionally, personnel inBangalore, India provide software development services to our globaloperations.  Financial informationrelating to operations by geographic region is as follows (in thousands):

 
| ** **      | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------|------------|---------------------------------------|------------|
| ** **      | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| ** **      | ** ** | **L&S**                           | ** ** | **CS** | ** ** | **Total** | ** ** | **L&S** | ** ** | **CS** | ** ** | **Total** | ** ** |
| **Revenue**     |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| United  States  |       | $                                     | 912        |   | $ | 2,091 |   | $ | 3,003 |   | $ | 683 |   | $ | 2,570 |   | $ | 3,253 |   |
| United  Kingdom |       | 505                                   |       | 513 |   | 1,018 |   | 687 |   | 494 |   | 1,181 |   |
| Indonesia       |       | 1,190                                 |       | 43 |   | 1,233 |   | 16 |   | 28 |   | 44 |   |
| Other           |       | 3,018                                 |       | 1,438 |   | 4,456 |   | 3,359 |   | 1,006 |   | 4,365 |   |
| Total  revenues |       | $                                     | 5,625      |   | $ | 4,085 |   | $ | 9,710 |   | $ | 4,745 |   | $ | 4,098 |   | $ | 8,843 |   |

 

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| ** **                  | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                  | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| **Long-lived  assets, net** |       |               |       |                  |       |
| United  States              |       | $                  | 6,693      |                  | $          | 6,759 |   |
| United  Kingdom             |       | 17,312             |       | 18,422                |       |
| Other                       |       | 223                |       | 174                   |       |
|                        |       | $                  | 24,228     |                  | $          | 25,355 |   |

 
| ** **           | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------|------------|---------------------------------------|------------|
| ** **           | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| **Revenue**          |       |                                  |       |   |   |
| Activation           |       | $                                     | 5,808      |   | $ | 4,842 |   |
| Numbering  solutions |       | 3,481                                 |       | 3,388 |   |
| Mediation            |       | 421                                   |       | 613 |   |
| Total  revenues      |       | $                                     | 9,710      |   | $ | 8,843 |   |

 

**NOTE10 — COMMITMENTS AND CONTINGENCIES**

 

**(a)          Other Commitments**

 

Aspermitted under Delaware law, we have agreements with officers and directorsunder which we agree to indemnify them for certain events or occurrences whilethe officer or director is, or was, serving at our request in this capacity.The term of the indemnification period is indefinite. There is no limit on theamount of future payments we could be required to make under theseindemnification agreements; however, we maintain Director and Officer insurancepolicies, as well as an Employment Practices Liability Insurance Policy, thatmay enable us to recover a portion of any amounts paid. As a result of ourinsurance policy coverage, we believe the estimated fair value of theseindemnification agreements is minimal. Accordingly, there were no liabilitiesrecorded for these agreements as of March 31, 2010 or December 31,2009.

 

Weenter into standard indemnification terms with customers and suppliers, in theordinary course of business, for third party claims arising under ourcontracts. In addition, as we may subcontract the development of deliverablesunder customer contracts, we could be required to indemnify customers for workperformed by subcontractors. Depending upon the nature of the indemnification,the potential amount of future payments we could be required to make underthese indemnification agreements may be unlimited. We may be able to recoverdamages from a subcontractor or other supplier if the indemnification resultsfrom the subcontractor’s or supplier’s failure to perform. To the extent we areunable to recover damages from a subcontractor or other supplier, we could berequired to reimburse the indemnified party for the full amount. We have neverincurred costs to defend lawsuits or settle claims relating to anindemnification. As a result, we believe the estimated fair value of theseagreements is minimal. Accordingly, there were no liabilities recorded forthese agreements as of March 31, 2010 or December 31, 2009.

 

Ourstandard license agreements contain product warranties that the software willbe free of material defects and will operate in accordance with the statedrequirements for a limited period of time. The product warranty provisions require us to cure any defects throughany reasonable means.  We believe theestimated fair value of the product warranty provisions in the licenseagreements in place with our customers is minimal.  Accordingly, there were no liabilitiesrecorded for these product warranty provisions as of March 31, 2010 or December 31,2009.

 

Oursoftware arrangements generally include a product indemnification provisionwhereby we will indemnify and defend a customer in actions brought against thecustomer for claims that our products infringe upon a copyright, trade secret,or valid patent of a third party. We have not historically incurred anysignificant costs related to product indemnification claims. Accordingly, therewere no liabilities recorded for these indemnification provisions as of March 31,2010 or December 31, 2009.

 

Inrelation to the acquisitions of Evolving Systems U.K., TSE and CMS, we agreedto indemnify certain parties from any losses, actions, claims, damages or liabilities(or actions in respect thereof) resulting from any claim raised by a thirdparty.  We do not believe that there willbe any claims related to these indemnifications. Accordingly, there were noliabilities recorded for these agreements as of March 31, 2010 or December 31,2009.

 

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**(b)         Litigation**

 

We are involved invarious legal matters arising in the normal course of business.  Losses, including estimated costs to defend,are recorded for these matters to the extent they were probable of loss and theamount of loss could be reasonably estimated.

 

**NOTE11 — RELATED PARTY TRANSACTIONS**

 

EffectiveOctober 15, 2009, George A. Hallenbeck resigned from our Board ofDirectors and we entered into a consulting agreement with him to provideconsulting services. Mr. Hallenbeck is one of the founders of the Company.Under the consulting agreement, we will pay Mr. Hallenbeck an annual feeof $10,000 for his services through May 31, 2012. We had currentobligations in the consolidated balance sheets, under the agreement of $2,500and $2,000 as of March 31, 2010 and December 31, 2009, respectively.We recorded approximately $2,500 of general and administrative expense in theconsolidated statements of operations, related to this agreement, for the threemonths ended March 31, 2010.

 

EffectiveMarch 12, 2010, Stephen K. Gartside, Jr., Chairman of the Board, 44,resigned from our Board of Directors We entered into a consulting agreementwith Mr. Gartside to provide consulting services to us. Under theconsulting agreement we will pay Mr. Gartside a fee of $7,000 for hisservices through December 31, 2010.

 

**NOTE12 — SUBSEQUENT EVENTS**

 

We evaluated our March 31, 2010 financial statements for subsequentevents. We are not aware of any subsequent events which would requirerecognition or disclosure in the consolidated financial statements.

 

**ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**SPECIAL NOTE ABOUT FORWARD-LOOKINGSTATEMENTS**

 

*ThisQuarterly Report on Form 10-Q contains forward-looking statements thathave been made pursuant to the provisions of the Private Securities LitigationReform Act of 1995.  Theseforward-looking statements are based on current expectations, estimates, andprojections about Evolving Systems’ industry, management’s beliefs, and certainassumptions made by management. Forward-looking statements include our expectations regarding product,services, and maintenance revenue, annual savings associated with theorganizational changes effected in prior years, and short- and long-term cashneeds.  In some cases, words such as “anticipates”,“expects”, “intends”, “plans”, “believes”, “estimates”, variations of thesewords, and similar expressions are intended to identify forward-lookingstatements.  The statements are notguarantees of future performance and are subject to certain risks,uncertainties, and assumptions that are difficult to predict; therefore, actualresults may differ materially from those expressed or forecasted in anyforward-looking statements.  Risks anduncertainties of our business include those set forth in our Annual Report on Form 10-Kfor the year ended December 31, 2009 under “Item 1A. Risk Factors” as wellas additional risks described in this Form 10-Q.  Unless required by law, we undertake noobligation to update publicly any forward-looking statements, whether as aresult of new information, future events, or otherwise.  However, readers should carefully review therisk factors set forth in other reports or documents we file from time to timewith the Securities and Exchange Commission, particularly the Quarterly Reportson Form 10-Q and any Current Reports on Form 8-K.*

 

**OVERVIEW**

 

We are a leading providerof software solutions and services to the wireless, wireline and cable markets.We maintain long-standing relationships with many of the largest wireless,wireline and cable companies worldwide. Our customers rely on us to develop,deploy, enhance, maintain and integrate complex, reliable software solutionsfor a range of Operations Support Systems (“OSS”).  Our activation solution is the leadingpackaged solution for activation in the wireless industry.

 

Werecognize revenue in accordance with the prescribed accounting standards forsoftware revenue recognition under generally accepted accountingprinciples.  Our license fees andservices revenues fluctuate from period to period as a result of the timing ofrevenue recognition on existing projects.

 

**RECENTDEVELOPMENTS**

 

Consolidated revenueincreased to $9.7 million from $8.8 million for three months ended March 31,2010 and 2009, respectively.  This growth is primarily the result ofincreased revenue from our DSA solution and International *NumeriTrack*.

 

We reported netincome of $1.2 million and $1.0 million for the three months ended March 31,2010 and 2009, respectively. This is the eighth consecutive quarter in which wehave reported net income.  Our twelvemonth backlog increased to $18.6 million as of March 31, 2010, compared to$17.8 million as of March 31, 2009.

 

We also had significant improvements to our balance sheet during thefirst quarter of 2010.  Cash grew to $8.7million at March 31, 2010 from $5.4 million at December 31, 2009despite $1.5 million in existing cash used to reduce our senior term note andU.K. Revolving Credit Facility.

 

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We have operationsin foreign countries where the local currency is used to prepare the financialstatements which are translated into our reporting currency, U.S. Dollars.Changes in the exchange rates between these currencies and our reportingcurrency are partially responsible for some of the changes from period toperiod in our financial statement amounts. The chart below summarizes how ourrevenue and expenses would change had they been reported on a constant currencybasis. The constant currency basis assumes that the exchange rate was constantfor the periods presented (in thousands).

 
| ** **                               | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------|------------|---------------------------------------|------------|
| ** **                               | ** ** | **2010 vs. 2009**                     | ** ** |
| ** **                               | ** ** | **Increase/(Decrease)**               | ** ** |
| Revenue                                  |       | $                                     | 243        |   |
| Costs  of revenue and operating expenses |       | 410                                   |       |
| Operating  income                        |       | $                                     | (167       | ) |

 

The net effect of our foreign currency translations for the three monthsended March 31, 2010 was a $0.2 million increase in revenue and a $0.4million increase in operating expenses versus the three months ended March 31,2009.

 

**RESULTSOF OPERATIONS**

 

Thefollowing table presents the unaudited consolidated statements of operationsreflected as a percentage of total revenue.

 
| ** **                                                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                   | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| **REVENUE**                                                                  | ** ** | ** **                            |       |   |   |
| License  fees and services                                                   |       | 58                                    | %          | 54 | % |
| Customer  support                                                            |       | 42                                    | %          | 46 | % |
| Total  revenue                                                               |       | 100                                   | %          | 100 | % |
|                                                                         |       |                                  |       |   |   |
| **COSTS OF REVENUE AND OPERATING EXPENSES**                                  |       |                                  |       |   |   |
| Costs  of license fees and services, excluding depreciation and amortization |       | 22                                    | %          | 19 | % |
| Costs  of customer support, excluding depreciation and amortization          |       | 12                                    | %          | 16 | % |
| Sales  and marketing                                                         |       | 20                                    | %          | 21 | % |
| General  and administrative                                                  |       | 15                                    | %          | 16 | % |
| Product  development                                                         |       | 12                                    | %          | 8 | % |
| Depreciation                                                                 |       | 2                                     | %          | 2 | % |
| Amortization                                                                 |       | 2                                     | %          | 2 | % |
| Total  costs of revenue and operating expenses                               |       | 85                                    | %          | 84 | % |
|                                                                         |       |                                  |       |   |   |
| Income  from operations                                                      |       | 15                                    | %          | 16 | % |
|                                                                         |       |                                  |       |   |   |
| Other  income (expense)                                                      |       |                                  |       |   |   |
| Interest  income                                                             |       | 0                                     | %          | 0 | % |
| Interest  expense                                                            |       | (0                                    | )%         | (3 | )% |
| Foreign  currency exchange gain (loss)                                       |       | (0                                    | )%         | (2 | )% |
| Other  income (expense), net                                                 |       | (0                                    | )%         | (5 | )% |
|                                                                         |       |                                  |       |   |   |
| Income  before income taxes                                                  |       | 15                                    | %          | 11 | % |
| Income  tax expense                                                          |       | 3                                     | %          | 0 | % |
| Net  income                                                                  |       | 12                                    | %          | 11 | % |

 

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***Revenue***

 

Revenueis comprised of license fees/services and customer support.  License fees and services revenue representthe fees we receive from the licensing of our software products and thoseservices directly related to the delivery of the licensed product as well asintegration and consulting services. Customer support revenue includes annual support, recurringmaintenance, maintenance upgrades and warranty services.  Warranty services consist of maintenanceservices and are typically bundled with a license sale and the related revenue,based on Vendor-Specific Objective Evidence (“VSOE”), and is deferred andrecognized ratably over the warranty period.  The followingtable presents our revenue by product group (in thousands):

 
| ** **           | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------|------------|---------------------------------------|------------|
| ** **           | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| **Revenue**          |       |                                  |       |   |   |
| Activation           |       | $                                     | 5,808      |   | $ | 4,842 |   |
| Numbering  solutions |       | 3,481                                 |       | 3,388 |   |
| Mediation            |       | 421                                   |       | 613 |   |
| Total  revenues      |       | $                                     | 9,710      |   | $ | 8,843 |   |

 

Revenuefor the three months ended March 31, 2010 and 2009 was $9.7 million and$8.8 million, respectively. The increase of $0.9 million was primarily due toincreased revenue from our *Dynamic SIM Allocation**TM*(“DSA”) product.

 

***License Fees and Services***

 

License fees andservices revenue increased $0.9 million, or 19%, to $5.6 million for the threemonths ended March 31, 2010 from $4.7 million for the three months ended March 31,2009.  Changes in license fees andservices revenue for the three months ended March 31, 2010 compared to thethree months ended March 31, 2009 included an increase of $0.5 million inrevenue from our activation products, an increase of $0.3 million in revenuefrom our numbering solutions products and an increase of $0.1 million inrevenue from our mediation products. This growth in our activation and numbering solutions product groups isdue to increased revenue from DSA and our legacy numbering products.

 

***Customer Support***

 

Customer supportrevenue remained consistent at $4.1 million for the three months ended March 31,2010 and 2009.  Within customer supportrevenue there was an increase in activation customer support revenue of $0.4million, offset by decreases in our numbering solutions and mediation productsof $0.2 million each.

 

***Costsof Revenue, Excluding Depreciation and Amortization***

 

Costsof revenue, excluding depreciation and amortization, consist primarily ofpersonnel costs and other direct costs associated with these personnel,facilities costs, costs of third-party software and partner commissions.  Costs of revenue, excluding depreciation andamortization, were $3.3 million and $3.1 for the three months ended March 31,2010 and 2009, respectively.

 

***Costs of License Fees and Services, Excluding Depreciation andAmortization***

 

Costs of license fees and services, excluding depreciation andamortization, increased $0.5 million, or 28%, to $2.1 million for the threemonths ended March 31, 2010 from $1.7 million for the three months ended March 31,2009.  The increase in costs is primarilythe result of the increased effort to support higher revenue during the periodand higher travel expenses related to our expanding international customerbase. As a percentage of license fees and services revenue, costs of licensefees and services, excluding depreciation and amortization, increased to 38%for the three months ended March 31, 2010 from 35% for the three monthsended March 31, 2009.  The increasein costs as a percentage of revenue is due to the increased travel expensesrelated to our expanding international customer base and the increased onsiteinvolvement of our DSA implementation team.

 

***Costs of Customer Support, Excluding Depreciation and Amortization***

 

Costs of customer support, excluding depreciation and amortization,decreased $0.3 million, or 21%, to $1.1 million for the three months endedMarch 31, 2010 from $1.4 million for the three months ended March 31,2009.  The decrease in costs of customersupport is primarily the result of our increased reliance on our lower costIndian work force. As a percentage of customer support revenue, costs ofcustomer support revenue, excluding depreciation and amortization, decreased to28% for the three months ended March 31, 2010 from 35% for the threemonths ended March 31, 2009.  Thesedecreases in costs as a percentage of revenue are primarily the result of theaforementioned increased reliance on our lower cost India work force.

 

***Salesand Marketing***

 

Salesand marketing expenses primarily consist of compensation costs, includingincentive compensation and commissions, travel expenses, advertising, marketingand facilities expenses. Sales and marketing expenses remained at $1.9 millionfor the three months ended March 31, 2010 and 2009.  As a percentage of total revenue, sales andmarketing expenses decreased to 20% for the three months ended March 31,2010 from 21% for the three months ended March 31, 2009. The decrease as apercentage of revenue is

 

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primarily due to increased revenue during the period.

 

***Generaland Administrative***

 

General and administrative expenses consist principally of employeerelated costs and professional fees for the following departments: facilities,finance, legal, human resources, and certain executive management.  General and administrative expenses increased$0.1 million, or 4%, to $1.5 million from $1.4 million for the threemonths ended March 31, 2010 and 2009, respectively.  The increase in costs is primarily due toincreased equity compensation related to the increased price of our commonstock. As a percentage of total revenue, general and administrative expensesfor the three months ended March 31, 2010 and 2009, decreased to 15% from16%, respectively.  The decrease as apercentage of revenue was primarily due to increased revenue during the period,partially offset by higher incentive compensation related to improved financialresults.

 

***ProductDevelopment***

 

Productdevelopment expenses consist primarily of employee related costs andsubcontractor expenses.  Product developmentexpenses increased $0.5 million, or 74%, to $1.2 million from $0.7 million forthe three months ended March 31, 2010 and 2009, respectively.  As a percentage of revenue, productdevelopment expenses for the three months ended March 31, 2010 and 2009, increasedto 12% from 8%, respectively.  Theincrease in expenses and as a percentage of revenue is primarily due to anincreased development effort on our DSA product and new features on our legacynumbering products.

 

***Amortization***

 

Amortizationexpense consists of amortization of identifiable intangible assets acquiredthrough our acquisitions of Evolving Systems U.K., TSE and CMS.  Amortization expense remained at $0.2 millionfor the three months ended March 31, 2010 and 2009. As a percentage ofrevenue, amortization expense for the three months ended March 31, 2010and 2009, remained at 2%.

 

***Depreciation***

 

Depreciationexpense consists of depreciation of long-lived property and equipment.  Depreciation expense remained at $0.2 millionfor the three months ended March 31, 2010 and 2009. As a percentage oftotal revenue, depreciation expense for the three months ended March 31,2010 and 2009, remained at 2%.

 

***InterestExpense***

 

Interestexpense includes interest expense on our long-term debt and capital leaseobligations as well as amortization of debt issuance costs.  Interest expense was $39,000 and $0.3 millionfor the three months ended March 31, 2010 and 2009, respectively. Thedecrease of $0.2 million is due to the early retirement of our subordinated debtduring 2009 and the retirement of our senior term loan.

 

***ForeignCurrency Exchange Gain (Loss)***

 

Foreign currency transaction gains (losses) resulted from transactionsdenominated in a currency other than the functional currency of the respectivesubsidiary and were $42,000 and $0.2 million for the three months ended March 31,2010 and 2009, respectively.  The gains(losses) were generated primarily through the re-measurement of certainnon-functional currency denominated financial assets and liabilities of ourEvolving Systems U.K. subsidiary.

 

***IncomeTaxes***

 

Werecorded net income tax expense of $0.2 million and $5,000 for the three monthsended March 31, 2010 and 2009, respectively.  The net expense during the three months endedMarch 31, 2010 consisted of current income tax expense of $0.3 million,partially offset by a deferred tax benefit of $0.1 million. The current taxexpense primarily related to income tax related to our U.K.-based operations,estimated Alternative Minimum Tax (“AMT”) due in the U.S. and MinimumAlternative Tax (“MAT”) related to our Indian subsidiary. The deferred taxbenefit was related to the intangible assets from our U.K.-based operations.The net expense during the three months ended March 31, 2009 consisted ofcurrent income tax expense of $56,000 and deferred tax benefit of $51,000. Thecurrent income tax expense and the deferred tax benefit were primarily relatedto our U.K.-based operations. Our effective tax rate of 17% for the threemonths ended March 31, 2010 was up from an effective rate of 1% for thethree months ended March 31, 2009. This increase in our effective tax rate relates principally to increasedearnings and reflects a more normalized rate of expected income tax expense.

 

Inconjunction with the acquisition of Evolving Systems U.K., we recorded certainidentifiable intangible assets.  Sincethe amortization of these identifiable intangibles is not deductible for incometax purposes, we established a long-term deferred tax liability of $4.6 millionat the acquisition date for the expected difference between what would beexpensed for financial reporting purposes and what would be deductible forincome tax purposes. As of March 31, 2010 and December 31, 2009, thiscomponent of the deferred tax liability was $0.4 million and $0.5 million,respectively.  This deferred taxliability relates to Evolving Systems U.K., and has no impact on our ability torecover U.S.-based deferred tax assets. This deferred tax liability will be recognized as a reduction ofdeferred income tax expense as the identifiable intangibles are amortized.

 

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We recorded a fullvaluation allowance against our U.S. net deferred tax assets as of March 31,2010 and December 31, 2009 as we determined that it was more likely thannot that we will not realize our U.S. deferred tax assets.  Such assets primarily consist of certain netoperating loss carryforwards. We made our assessment of the realizability ofour domestic deferred tax assets using all available evidence. In particular,we considered both historical results and projections of profitability for onlythe reasonably foreseeable future periods and any tax planning strategies. TheInternal Revenue Code places certain limitations on the annual amount of netoperating loss carry forwards which can be utilized if certain changes inownership occur.  Changes to ourownership occurred in 2004 which limit the future utilization of the netoperating losses generated prior to the ownership change. Should we continue togenerate taxable income in the U.S., we may need to reassess our valuationallowance.

 

**FINANCIALCONDITION**

 

Ourworking capital position increased $0.2 million to $5.0 million as of March 31,2010 from $4.8 million as of December 31, 2009.

 

**CONTRACTUALOBLIGATIONS**

 

Therehave been no material changes to the contractual obligations as disclosed inour 2009 Annual Report on Form 10-K.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

Wehave historically financed operations through cash flows from operations andequity transactions.  At March 31,2010, our principal source of liquidity was $8.7 million in cash and cashequivalents, $6.8 million in contract receivables, net of allowance, as well as$5.6 million available under our revolving credit facilities.

 

Netcash provided by operating activities for the three months ended March 31,2010 and 2009 was $4.7 million and $3.6 million, respectively.  The increase in cash provided by operatingactivities for the three months ended March 31, 2010 was due primarily toimproved financial results and during the three months ended March 31,2009 we paid $1.2 million of accrued interest on our subordinated debt.

 

Netcash used in investing activities during each of the three months ended March 31,2010 and 2009 was $0.2 million.  The cashused for the three months ended March 31, 2010 and 2009 was related topurchases of property and equipment.

 

Netcash used in financing activities for the three months ended March 31,2010 and 2009 was $1.3 million and $1.1 million, respectively.  Financing activities in the three monthsended March 31, 2010 consisted primarily of principal payments on existingdebt, of approximately $1.5 million, partially offset by cash receipts of $0.2million related to exercises of stock options. Financing activities in the three months ended March 31, 2009consisted primarily of principal payments on existing debt, of approximately$1.1 million.

 

Webelieve that our current cash and cash equivalents, together with anticipatedcash flow from operations and availability under our revolving line of creditwill be sufficient to meet our working capital, capital expenditure andfinancing requirements for at least the next twelve months. In making thisassessment we considered the following:

 

·                  Our cash and cash equivalents balance at March 31,2010 of $8.7 million;

 

·                  The availability under our revolving credit facilitiesof $5.6 million at March 31, 2010;

 

·                  Our working capital balance of $5.0 million;

 

·                  Our demonstrated ability to generate positive cashflows from operations;

 

·                  Our backlog as of March 31, 2010 of approximately$18.6 million, including $6.7 million in license fees and services and $11.9million in customer support.

 

We are exposed to foreigncurrency rate risks which impact the carrying amount of our foreignsubsidiaries and our consolidated equity, as well as our consolidated cashposition due to translation adjustments. For the three months ended March 31, 2010, the effect of exchangerate changes resulted in a $0.1 million increase to consolidated cash.  During the three months ended March 31,2009, the effect of exchange rate changes resulted in a $0.1 million decreasein consolidated cash.  We do notcurrently hedge our foreign currency exposure, but we monitor rate changes andmay hedge our exposures if we see significant negative trends in exchangerates.

 

**OFF-BALANCESHEET ARRANGEMENTS**

 

Wehave no off-balance sheet arrangements that have a material current effect orthat are reasonably likely to have a material future effect on our financialcondition, changes in financial condition, revenues or expenses, results ofoperations, liquidity, capital expenditures or capital resources.

 

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**ITEM3.  QUANTITATIVE AND QUALITATIVE MARKETRISK DISCLOSURES**

 

In the ordinarycourse of business, we are exposed to certain market risks, including changesin interest rates and foreign currency exchange rates. Uncertainties that areeither non-financial or non-quantifiable such as political, economic, tax,other regulatory, or credit risks are not included in the following assessmentof market risks.

 

***InterestRate Risks***

 

Our cash balancesare subject to interest rate fluctuations and as a result, interest incomeamounts may fluctuate from current levels. We could be exposed to interest rate risk related to our seniorrevolving credit facilities entered into in February 2008.  These obligations are variable interest ratenotes based on Prime Rate.  Fluctuationsin Prime Rate affect our interest rates. As of March 31, 2010 and December 31,2009, there was $0.4 million and $1.5 million outstanding on our seniorrevolving credit facilities.

 

***ForeignCurrency Risk***

 

We are exposed to favorableand unfavorable fluctuations of the U.S. dollar (our functional currency)against the currencies of our operating subsidiaries. Any increase(decrease) in the value of the U.S. dollar against any foreign currencythat is the functional currency of one of our operating subsidiaries will causethe parent company to experience unrealized foreign currency translation losses(gains) with respect to amounts already invested in such foreigncurrencies.  In addition, we and ouroperating subsidiaries are exposed to foreign currency risk to the extent thatwe enter into transactions denominated in currencies other than our respectivefunctional currencies, such as accounts receivable (including intercompanyamounts) that are denominated in a currency other than their own functionalcurrency. Changes in exchange rates with respect to these items will result inunrealized (based upon period-end exchange rates) or realized foreign currencytransaction gains and losses upon settlement of the transactions. In addition,we are exposed to foreign exchange rate fluctuations related to our operatingsubsidiaries’ monetary assets and liabilities and the financial results offoreign subsidiaries and affiliates when their respective financial statementsare translated into U.S. dollars for inclusion in our consolidated financialstatements. Cumulative translation adjustments are recorded in accumulatedother comprehensive income (loss) as a separate component of equity. As aresult of foreign currency risk, we may experience economic loss and a negativeimpact on earnings and equity with respect to our holdings solely as a resultof foreign currency exchange rate fluctuations.

 

Therelationship between the British Pound Sterling, Indian rupee and the U.S.dollar, which is our functional currency, is shown below, per one U.S. dollar:

 
| ** **           | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------|------------|--------------------|------------|-----------------------|------------|
| **Spot rates:**      | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| Great  British pound |       | 0.66349            |       | 0.62792               |       |
| Indian  rupee        |       | 45.02476           |       | 46.75082              |       |

 
| ** **           | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------|------------|---------------------------------------|------------|
| **Average rates:**   | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Great  British pound |       | 0.64148                               |       | 0.69606 |   |
| Indian  rupee        |       | 46.02628                              |       | 50.51857 |   |

 

At the present time, we do not hedge our foreign currency exposure or usederivative financial instruments that are designed to reduce our long-termexposure to foreign currency exchange risk.  To the extentthat translation and transaction gain and losses become significant, we willconsider various options to reduce this risk.

 

**ITEM4.  CONTROLS AND PROCEDURES**

 

We maintain “disclosurecontrols and procedures,” as such term is defined in Rule 13a-15(e) underthe Securities Exchange Act of 1934 (the “Exchange Act”), that are designed toprovide reasonable assurance that information required to be disclosed by us inreports that we file or submit under the Exchange Act is recorded, processed,summarized, and reported within the time periods specified in Securities andExchange Commission rules and forms, and that such information isaccumulated and communicated to our management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosure.

 

Our management,including our Chief Executive Officer and Chief Financial Officer, hasevaluated the effectiveness of our disclosure controls and procedures as of theend of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and Chief FinancialOfficer have concluded that our disclosure controls and procedures wereeffective as of the end of such period.

 

In designing andevaluating our disclosure controls and procedures, management recognized thatdisclosure controls and procedures, no matter how well conceived and operated,can provide only reasonable, not absolute, assurance that the objectives of the

 

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disclosure controls and procedures are met.  Additionally, indesigning disclosure controls and procedures, our management necessarily wasrequired to apply its judgment in evaluating the cost-benefit relationship ofpossible disclosure controls and procedures. The design of any disclosurecontrols and procedures also is based in part upon certain assumptions aboutthe likelihood of future events, and there can be no assurance that any designwill succeed in achieving its stated goals under all potential futureconditions.

 

During the threemonths ended March 31, 2010, there were no changes in our internalcontrols over financial reporting (as defined in Rule 13a-15(f) underthe Exchange Act) or in other factors that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

**PART II— OTHER INFORMATION**

 

**ITEM1.  LEGAL PROCEEDINGS**

 

We are involved invarious legal matters arising in the normal course of business.  Losses, including estimated costs to defend,are recorded for these matters to the extent they were probable of loss and theamount of loss could be reasonably estimated.

 

**ITEM1A.  RISK FACTORS**

 

Althoughwe have never declared or paid cash dividends on our common stock, our Board ofDirectors may elect to do so in the future. Our decision to pay dividends inthe future will depend on general business conditions, the impact of suchpayment on our financial condition and other factors our Board of Directors mayconsider to be relevant. In addition, since our revolving credit facilitycurrently prohibits us from declaring dividends to our common stockholders, anydividend payments would need to be approved by the financial institution whichissued our revolving credit facility. If we elect to pay dividends, this couldreduce our cash reserves to levels that may be inadequate to fund expansions toour business plan or unanticipated contingent liabilities.

 

This Quarterly Report on Form 10-Q should be readin conjunction with the risk factors defined in our Annual Report on Form 10-Kfor the year ended December 31, 2009 under “Item 1A. Risk Factors.”

 

**ITEM2.  UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

 

None

 

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

 

None

 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

None

 

**ITEM 5. OTHER INFORMATION**

 

None

 

**ITEM6.  EXHIBITS**

 

(a)          Exhibits

 

Exhibit 4.5 — Second Amendment to RightsAgreement dated as of December 10, 2009, between Evolving Systems, Inc.and American Stock Transfer & Trust Company LLC

Exhibit 10.22 — Consulting Agreement entered intowith Stephen K. Gartside, Jr., as filed as Exhibit 10.1 to theCompany’s Form 8-K filed March 12, 2010 and incorporated herein byreference

Exhibit 31.1 — Certification pursuant to Section 302of the Sarbanes-Oxley Act of 2002

Exhibit 31.2 — Certification pursuant to Section 302of the Sarbanes-Oxley Act of 2002

Exhibit 32.1 — Certification pursuant to Section 906of the Sarbanes-Oxley Act of 2002

Exhibit 32.2 — Certification pursuant to Section 906of the Sarbanes-Oxley Act of 2002

 

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**SIGNATURE**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
| Date:  May 6, 2010 | /s/ BRIAN R.  ERVINE                          |
|-------------------------|-----------------------------------------------|
|                    | Brian R. Ervine                               |
|                    | Executive Vice  President,                    |
|                    | Chief Financial  and Administrative Officer,  |
|                    | Treasurer and  Assistant Secretary            |
|                    | (Principal  Financial and Accounting Officer) |

 

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